Argentina economy: Argentina secures vital US$50bn IMF deal

The Treasury minister, Nicolás Dujovne, and the governor of the Banco Central de la República Argentina (BCRA, the central bank), Federico Sturzenegger, announced on June 7th that Argentina had reached a three‑year, US$50bn high-access stand-by arrangement with the IMF.

Under the terms of the deal, the government has adopted somewhat tougher fiscal targets, under which the primary deficit will be eliminated in 2020 and move into surplus in 2021. The government has also committed to giving the central bank full independence to establish inflation targets.

Argentina's IMF deal provides the breathing room needed for the government continue with the adjustments needed to address Argentina's macroeconomic imbalances. A combination of tougher fiscal targets and greater central bank autonomy will be well received by markets.

The government was keen to take ownership of the deal and highlight measures supportive of the social safety net that are included in the arrangement. In this way it hopes to ink a deal that satisfies both markets and voters, and helps to ensure political and policy continuity after next year's presidential election. We continue to assume that the president, Mauricio Macri, will be re‑elected.

The deal has yet to be approved by the IMF executive board, which is to meet on June 20th (at which point a first disbursement of US$15bn will be made). For this reason, full details of conditionality, including quantitative targets and any microeconomic reform goals, are as yet unavailable from the Fund. Key metrics, have, however, been noted by Mssrs Dujovne and Sturzenegger, who are joint signatories to the deal. Important among these is the introduction of somewhat tougher fiscal targets in 2018‑19, which will require cuts of an accumulated 1.4% of GDP over and above previous targets. For this year, the recently revised target for the primary fiscal deficit of 2.7% of GDP is unchanged. For 2019 the new target is 1.3% of GDP, versus a previous target of 2.2% of GDP and roughly in line with our expectations. The deal then envisages a more rapid shift into fiscal balance in 2020 and into a primary fiscal surplus of 0.5% of GDP in 2021, the last year of the agreement.

A reset for monetary policy

The government and the central bank have also used the IMF deal as a reset for the monetary policy framework. Importantly, the central bank is to be given greater autonomy in law to not only conduct policy but also set its own inflation targets (a practice that has until now been in the hands of the executive), and central bank financing of the Treasury is to be eliminated more rapidly than previously envisaged. Central bank financing of the Treasury through short-term loans and the transfer of notional profits spiked under the previous government (2007‑15), amid expansionary fiscal policy and the country's pariah status in international capital markets.

The Macri administration has reduced the use of BCRA financing in its first two years in power, but still has a significant fiscal deficit to be covered, and the central bank is a not-insignificant—and inflationary—source of financing for this. The IMF deal will provide a low-cost alternative and make the BCRA's task of conducting appropriate monetary policy, reducing inflation and rebuilding the reserves easier (although the more fundamental issue of the fiscal deficit itself is of primary importance).

With his new powers to set the inflation target, Mr Sturzenegger has announced new targets, which he describes as realistic and achievable, of 17% for end-2019, 13% for 2020 and 9% for 2021 (there is now no specific target for 2018, presumably on the basis that it is not worthwhile to set an inflation target for six months ahead in a context of supply-side shocks). These targets are much higher than the previous targets for 2019 (10%) and 2020 (5%), and give much more leeway for price pressures emanating both from regulated price adjustments (needed to reduce the fiscal burden of subsidies and make investment in utilities more attractive by restoring prices to market levels) and currency depreciation, which is expected to continue, though at a more measured pace, as adjustment of the overvalued peso continues.

Higher inflation, weaker growth and a social safety net

The new inflation targets are only very slightly below current market expectations, and do appear achievable, if not underambitious, and the prospect of double‑digit inflation for another two and a half years may be of concern to markets. Another sobering statement by Mr Dujovne centred on the government's growth assumptions for this year (0.4‑1.5%) and next (1.5‑2.5%). In the 2018 budget, presented just nine months ago in September 2017, the government had projected growth of 3.5%; a severe drought early this year accounts for much of the downward adjustment to the growth outlook for 2018, but the government is clearly also now expecting a substantial impact on growth from tighter fiscal policy, and, presumably, weaker consumer purchasing power and business confidence (Brazil's economic woes as its economic recovery stumbles will not help).

In this context, the government was keen to highlight provisions in the deal for spending to support the social safety net. Although some detail of provisions for social spending (as with other areas of the deal) are lacking in the absence of a full statement from the IMF to date, Mr Dujovne has made clear that the government will have leeway to adapt its fiscal deficit targets if needed. This may be necessary to allow for an additional 0.2% of GDP in social spending (for example on conditional cash transfer programmes) and to make adjustments to the composition of expenditure to increase social spending as necessary over and above this amount.

According to Mr Dujovne, this provision is unique among Fund financing arrangements. That said, the IMF has in recent years also increasingly emphasised the importance of spending on the social safety net to ensure the political and social sustainability of its traditional balance-of-payments adjustment prescriptions. With such measures, both the IMF and Argentina will be trying to emphasise to a sceptical domestic audience that views the Fund with suspicion that "this time is different", and that the deal is merely providing financing space for the government to get back on track with its own programme of economic reforms.

With a presidential election due in October 2019, mid-way through the three-year Fund arrangement, these efforts to highlight the importance of the country's social safety net will be vital to ensuring that the programme satisfies both voters and the markets. This, in turn, will be key to policy continuity beyond next year's presidential polls. We continue to assume that Mr Macri will be re‑elected next year, but substantial risks to that forecast persist for the time being.